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Amidst the debate over exactly what constitutes a “debt default” and exactly when that might occur, there are growing signs that debt limit brinkmanship is already damaging the economy. Yesterday Wonkblog’s Neil Irwin drew attention to an alarming rise in interest rates for 30-day Treasury bills. Today at National Journal, Patrick Reis and Catherine Hollander more broadly address the effects of debt default fears on Ben Bernanke’s very precise strategy for managing a fragile economic recovery:

Ben Bernanke has spent half of a decade trying to coax investors out of their post-recession bunkers. Now, Congress is set to once again send them running for cover.

The country will default in the coming weeks unless lawmakers reach a debt ceiling deal, but just by coming close to the edge, Congress will pull markets in the exact opposite direction than the Federal Reserve has been trying to push them.

Bernanke’s bid to resuscitate the economy depends on two leaps of faith. Businesses need to have enough faith in the future to ask for the big loans they need to expand their operations, in part by hiring some of the country’s 11.3 million unemployed workers. And lenders need to believe that making those loans is the best use of their money.

The Fed’s ongoing quest to drive down interest rates targets both goals. By keeping rates low, Bernanke makes it cheaper for borrowers to take out loans. And to convince lenders to take a risk on those loans, the Fed has bought up massive quantities of Treasury bonds—considered the ultimate safe investment among investors—in an effort to drive down the rate at which those bonds pay off to private investors. The hope is that investors, unsatisfied at the low rate of return they get back from the federal government, will instead put their money into the private sector.

That’s where Congress is so damaging to Bernanke’s efforts. By precipitating one crisis after another, lawmakers are sending investors running back to the type of investments that keep their money safe but do precious little in the way of economic stimulus.

If Congress wanted to spook lenders, it could hardly pick a better method than flirting with default. “It would be the opposite of what the Fed’s wanted to do,” says Stuart Hoffman, chief economist at PNC Financial Services. “It basically says something has happened outside the Fed’s control that could shock the economy into recession.”

Thanks again, congressional Republicans. Too bad you couldn’t wait for the midterms or the next presidential election to boost the credibility of your political demands, and had to take hostages instead.

Ed Kilgore
is a contributing writer to the Washington Monthly. He is managing editor for The Democratic Strategist and a senior fellow at the Progressive Policy Institute. Find him on Twitter: @ed_kilgore.

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